Edited version of your written advice

Authorisation Number: 1012998161156

Date of advice: 22 April 2016

Ruling

Subject: Small Business CGT Concessions

Question 1:

Does your 50% interest in the property that you acquired on XX/XX/XXXX, satisfy the basic conditions for the small business CGT concessions under section 152-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer:

Yes.

Question 2:

Does your inherited 50% interest in the property satisfy the basic conditions for the small business CGT concessions under section 152-10 of the ITAA 1997?

Answer:

No.

This ruling applies for the following period:

Year ending 30 June 2016

The scheme commenced on

1 July 2015

Relevant facts

You and your spouse formed a partnership in 19XX.

You and your spouse purchased a property on XX/XX/XXXX.

The property was used for farming activities since 19XX.

You and your spouse lodged partnership returns for the farming activity.

In 20XX a family trust (the trust) was created.

Your spouse passed away and the farming activity carried on by the partnership ceased and was carried on by the trust.

The title of the land transferred to you as the surviving spouse.

The trust did not own the property.

In 20XX the trust leased a substantial area of the property to a third party.

The trust returned Primary production and Non- primary production income.

The Non- primary production income (rent) was substantially more than the Primary production income.

The trust ceased its farming activities in 20XX.

The net value of the CGT assets held by you and the trust for the purposes of the maximum net asset value test is under six million dollars.

You were not connected or affiliated with any other entities besides the trust.

You entered into a contract of sale with a third party to sell the property.

The sale of the property will result in a capital gain.

You are under 55 years of age.

You are the sole trustee and beneficiary of the trust.

Relevant legislative provisions

Income Tax Assessment Act 1997 Paragraph 108-5(1)(a)

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 152-10

Income Tax Assessment Act 1997 Paragraph 152-10(1)(d)

Income Tax Assessment Act 1997 Section 152-15

Income Tax Assessment Act 1997 Section 152-35

Income Tax Assessment Act 1997 Subsection 152-35(1)

Income Tax Assessment Act 1997 Paragraph 152-35(1)(b

Income Tax Assessment Act 1997 Paragraph 152-40(1)(a)

Income Tax Assessment Act 1997 Paragraph 152-40(1)(e)

Income Tax Assessment Act 1997 Subparagraph 152-40(1)(a)(i)

Reasons for decision

Summary

Your 50% interest in the property acquired on XX/XX/XXXX satisfies the basic conditions under section 152-10 of the ITAA 1997 for the following reasons:

• you sold an asset giving rise to a CGT event which resulted in a gain

• you meet the maximum net asset value test, and

• you used the asset in a business carried on by partnership for more than 7 ½ years.

Therefore, you are entitled to apply the CGT 50% discount and the small business 50% active asset reduction to any capital gain made on the disposal of the property. If you satisfy the conditions for more than one of the remaining small business concessions, you may apply each of those concessions to different parts of the capital gain.

You cannot access the small business CGT concessions in regards to the 50% interest you inherited from your spouse as the property is not considered to be an active asset during the period from when you inherited the interest to when it was disposed of as the property was mainly used to derive rent. Therefore you do not satisfy the basic conditions under section 152-10 of the ITAA 1997. Accordingly the small business CGT concessions are not available to you in relation to the 50% interest in the property you inherited from your spouse. However, you are entitled to apply the CGT 50% discount to any capital gain made on the disposal of the 50% interest in the property you inherited from your spouse.

Detailed reasoning

Death and the small business CGT concessions for the remaining property

The legal personal representative (LPR) or beneficiary of the deceased estate will be eligible for the small business CGT concessions where:

• the asset is disposed of within two years of the date of death (although the Commissioner may allow a longer period by granting an extension of time), and

• the asset would have qualified for the small business CGT concessions if the deceased had disposed of the asset immediately before his or her death.

Provided these conditions are satisfied, the CGT small concessions are also available to the trustee of a trust established by the will of the deceased, a beneficiary of such a trust, and a surviving joint tenant.

However, if the asset in question is not disposed of within the two-year time limit, the conditions for the small business concessions must be satisfied by the new owner.

If a person carrying on a business dies and their assets devolve to their LPR, beneficiary, surviving joint tenant or trustee or beneficiary of a testamentary trust (the transferee), the active asset test is applied to the transferee in relation to any capital gain made on a sale of the assets after the two-year time limit (or such further time that the Commissioner allows). This means that if the transferee does not continue to carry on the deceased's business, or use the asset in another business, after the two-year time limit, the active asset test may not be satisfied and the small business concessions may not be available.

In your case, you acquired your deceased spouse's portion of the property giving you 100% ownership of the property. However, the property was not disposed of within two years of the date of death of your spouse. Accordingly, you will need to satisfy the conditions necessary to access the small business CGT concessions.

Small business CGT concession eligibility

Section 152-10 of the Income Tax Assessment Act 1997 (ITAA 1997) contains the basic conditions you must satisfy to be eligible for the small business capital gains tax (CGT) concessions. These conditions are:

(a) a CGT event happens in relation to a CGT asset in an income year.

(b) the event would have resulted in a gain

(c) at least one of the following applies:

(i) you are a small business entity for the income year

(ii) you satisfy the maximum net asset value test in section 152-15 of the ITAA 1997

(iii) you are a partner in a partnership that is a small business entity for the income year and the CGT asset is an asset of the partnership or

(iv) the conditions in subsection 152-10(1A) or (1B) of the ITAA 1997 are satisfied in relation to the CGT asset in the income year.

(d) the CGT asset satisfies the active asset test in section 152-35 of the ITAA 1997.

Basic condition a)

This condition requires a CGT event to happen in relation to your CGT asset in an income year. The asset in question is real estate (the property). A CGT asset includes any kind of property (paragraph 108-5(1)(a) of the ITAA 1997) and therefore the property is a CGT asset. The relevant CGT event will be the disposal of the property, which will cause CGT event A1 to happen (section 104-10 of the ITAA 1997).

In this case, you acquired the property as a joint tenant with your late spouse and over time you have acquired two interests in the property; a 50% interest when you originally acquired the properties in 19XX and a 50% interest from your late spouse upon their passing away in 20XX.

Each of the two interests is considered to be separate CGT assets and must be dealt with separately.

As the CGT events have happened in relation to a CGT asset of yours in the income year, this condition will be satisfied.

Note: If a deceased person acquired their asset on or after 20 September 1985, the first element of the beneficiary's cost base and reduced cost base is taken to be the cost base and reduced cost base of the asset on the day the person died that is, the surviving joint tenant inherits the deceased person's cost base.

Basic condition b)

The sale of the property, that is, the CGT event, did result in a capital gain, and therefore this condition will be satisfied.

Basic condition c)

You have advised that you satisfy the maximum net asset value test.

Basic condition d)

This condition requires that the active asset test in section 152-35 of the ITAA 1997 is satisfied.

Subsection 152-35(1) of the ITAA 1997 states that a CGT asset satisfies the active asset test if:

• you have owned the asset for 15 years or less and the asset was an active asset of yours for a total of at least half of the period of ownership, or

• you have owned the asset for more than 15 years and the asset was an active asset of yours for a total of at least 7 and a half years.

A CGT asset is an active asset if at a given time, among other things, it is owned and used (or held ready to use) in the course of carrying on a business (paragraph 152-40(1)(a) of the ITAA 1997)

Importantly, paragraph 152-40(4)(e) of the ITAA 1997 provides that an asset whose main use is to derive rent cannot be an active asset.

To satisfy the active asset test then, as both interests have been held for more than 15 years, the assets need to have been active assets for a total of at least 7 ½ years each, during each ownership period.

In this case, the property was used for a dual purpose over the period of ownership.

First interest in the property

The first interest in the property was held for more than 15 years and the property was an active asset from 19XX to 20XX a period of more than 7½ years as the partnership used the asset as part of its farming operation. Therefore your 50% share in the property is considered an active asset. Therefore basic condition (d) is satisfied in relation to your first interest held in the property.

However as you did not dispose of the property within two years from the date of death of your spouse we need to consider whether the inherited 50% part (the second interest) of the property was used as an active asset.

Second interest in the property

In your case, the second interest in the property was held from 20XX until it was disposed of, a period of more than 7½ years.

Taxation Determination TD 2006/78 considers, amongst other issues, the situation where there is part business and part rental use of an asset. It states that an asset owned by the taxpayer and used partly for business purposes and partly to derive rent can be an active asset under subsection 152-40(4) of the ITAA 1997 where it is considered that the main use of the premises is not to derive rent. In deciding if the property was mainly used to earn rent the Commissioner will consider a range of factors such as:

• the comparative areas of use of the premises (between rent and business)

• the comparative times of use of the premises (between rent and business), and

• the comparative levels of income derived from the different uses of the asset.

In this case, substantially more than 50% of the total area of the property was used to derive rent from a commercial lease with a small area of the property being used for farming activities carried on by the trust.

The income derived from the property during this period was rental income from an unrelated 3^rd party and primary production income from the farming activity. The percentage of income derived from renting the premises during the period was substantially more than the primary production income.

After considering the range of factors noted above such as the comparative times, the area of the premises used for leasing and the levels of income which shows the rental income was greater than the primary production income we consider that the main use of the property was to derive rent.

Accordingly, the second interest in the property is not considered to be an active asset for the purposes of subparagraph 152-40(1)(a)(i) of the ITAA 1997 and therefore fails the active asset test requirement that the asset must have been active for at least 7½ years in terms of paragraph 152-35(1)(b) of the ITAA 1997. As the second interest is not an active asset, it does not satisfy the basic conditions for the small business CGT concessions set out in Sub-division 152-A of the ITAA 1997 and those concessions will not be available to your inherited 50% interest in the property.